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 This topic has 3 replies, 2 voices, and was last updated 8 years ago by John Moffat.

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August 20, 2014 at 8:34 am #191607Accountaholic
 Topics: 98
 Replies: 67
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Cost of Capital – 14%
Cost of investment – $500,000
No yield in 1st year
From year 2 – cash inflows of $100,000 per annum in perpetuity.I think I am missing a point in the solution. I calculate as follows:
100,000 x 1/0.14 = $714,300
less
NPV for 1st year – $100,000 x 0.877 = $877000It does not seem to be right… ๐
As per solution the have deducted NPV for 2 years using present value factor 0.769
which gives $549,300 hence a positive NPV of $49300.Sir Mike can you please clear my doubt? I am sure it’s something little I am missing here.
Thanks
August 20, 2014 at 10:26 am #191622John MoffatKeymaster Topics: 57
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It is me who teaches F9 – not Mike ๐
Two things:
Firstly, something has gone wrong with your arithmetic. 100,000 x 1/0.14 = 714,300, that is correct. However, 100,000 x 0.877 = 87,700 (not 877,000 ๐ )
This would give an PV of 626,600 and an NPV of 126,600.(The alternative approach is to take the 714300 (which is the PV of a perpetuity starting in 1 years time, but then to multiply by the 1 year factor to account for the fact that it starts 1 year late. 714,300 x 0.877 = 626,441. The difference is purely the rounding of the discount factors and is irrelevant – you can do it whichever way you find more easy)
Secondly, are you sure you have typed the question exactly as it was written? If the first cash flow is at time 2 (i.e. in 2 years time) then what you have done is correct (apart from your arithmetic mistake), and the solution is wrong.
If, on the other hand, the wording is just slightly different (such as, for example, cash flows are 100,000 after the second year) then it would mean that the first cash flow would be in 3 years time which would make the solution correct. However they have not subtracted the 2 year factor – they have multiplied by it because they are taking the perpetuity back 2 years because it starts 2 years late. The alternative would have been two subtract the 2 year annuity discount factor which would give the same answer.
August 22, 2014 at 7:58 pm #191948Accountaholic Topics: 98
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Of course you teach F9 Sir John! ๐ ๐
I do apologise…I have no idea how I confused myself!!
Although I did not copy the question word to word, what I have mentioned is as per the question.
I will have to redo the question and see if I still read the same way!
Thank you for your help Sir John ๐
Regards
August 23, 2014 at 8:36 am #191978John MoffatKeymaster Topics: 57
 Replies: 50544
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You are welcome ๐

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